Looking at the stock market, it's hard to believe the U.S. is in the middle of a pandemic and experienced one of the sharpest plunges into recession in memory. At one point, the market, as measured by the broad S&P 500 index, was down by more than 30%. But with the exception of companies in hard-hit industries like cruising and air travel, stocks have recovered most of their February and March losses, putting the S&P 500 on track to shortly get back to year-to-date gains.
If you missed out on that big rally back from the market's late-March low, you might be tempted to bargain hunt among stocks that haven't rebounded. Specifically, you might be looking at cruise stocks like Royal Caribbean (NYSE: RCL), which are still extremely cheap. Here's why that would be a mistake.
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1. The September restart date looks too optimistic
On Tuesday, the cruise industry received a much-needed shot in the arm after promising vaccine trial news from Moderna. The Massachusetts-based biotech reported that its COVID-19 vaccine candidate had produced the looked-for immune response in clinical trial volunteers, and a large phase 3 study is about to get under way. Moderna's goal at this point, according to the company's CEO Stephen Hoge, is to have that vaccine available for broad distribution by the end of 2020 or early 2021.
But while this development is great news, it's just one step in the process. And even under the most optimistic scenario -- in which this early candidate is effective at preventing COVID-19 -- the vaccine probably won't make it to the public in time to help Royal Caribbean meet its overly optimistic restart timeline.
Royal Caribbean announced plans to start getting most of its ships back to cruising again by October 1, if health authorities allow it. This is possible because the Centers for Disease Control and Prevention's no-sail order expires on September 30. However, health authorities are likely to extend the restriction even further due to the rising numbers of daily new coronavirus diagnoses in the U.S. As mentioned in the CDC press release, cruise ships are more crowded than typical urban settings, and if unrestricted cruise ship passenger travel is allowed to resume, quote "passengers and crew on board would be at increased risk of COVID-19 infection".
The U.S. cruise industry could also face challenges due to foreign ports being unwilling to accept American tourists. The European Union, a handful of other countries on the Continent, and several more in Asia have imposed restrictions that will keep out most U.S. passport holders, although Latin America and the Caribbean are still significantly more accessible.
2. Heavy debt load and rising interest expense
Royal Caribbean needs to restart operations as soon as possible because of its high cash burn rate and its spiraling debt load. The problem is, even if the company survives the crisis, it will be left with a pile of high-interest loans and shareholder dilution that could suppress cash flow and cause the stock to underperform the market over the long term.
Royal Caribbean reported long-term debt of $12.27 billion in the first quarter. In June, it closed a private offering for an additional $1 billion in 9.125% senior guaranteed notes and $1.15 billion in 4.250% convertible senior notes (which could lead to shareholder dilution if the creditor decides to swap them for equity), both due in 2023. This capital raise followed a May offering for $1 billion in 10.875% notes and $2.32 billion in 11.5% notes due in 2025. This high interest/early maturity debt will put a tremendous strain on Royal Caribbean's free cash flow in the coming years.
The company reported interest expense of $408.5 million in fiscal 2019 which was around 20% of the year's $2.08 billion operating income. Investors can expect these figures to worsen significantly in its fiscal 2020.
At a current price of around $58, Royal Caribbean stock is trading at a significant discount to its January high of $135. But the stock is cheap for good reasons, and investors shouldn't ignore them.
Management's targeted September restart date looks too optimistic considering the rapidly spiking COVID-19 outbreaks all across the United States. And the company's overall financial situation will keep negative pressure on the stock for years, even after the pandemic is brought under control. The company will probably continue to underperform the market because of these challenges.
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